The stronger U.S. dollar may have unintended consequences on financial stocks and sector-related exchange traded funds as banks are forced to hold greater capital to meet regulatory requirements.
Wall Street banks are concerned that the steep appreciation in the U.S. dollar could force them to hold billions of dollars more in capital than foreign competitors due to the way the Federal Reserve calculates a so-called surcharge on the eight most systematically important U.S. banks, the Wall Street Journal reports.
Since the USD has appreciated against the euro and other global currencies, the high exchange rate makes U.S. dollar-denominated assets and operations appear larger relative to Europe and global peers. Consequently, U.S. banks would be required to hold greater capital and incur an higher surcharge cost because of the stronger dollar.
Under the new Federal Reserve regulatory rules, J.P. Morgan (NYSE: JPM), Bank of America Corp. (NYSE: BAC), Wells Fargo & Co. (NYSE: WFC), Goldman Sachs Group Inc. (NYSE: GS), Morgan Stanley (NYSE: MS), Bank of New York Mellon Corp. (NYSE; BK), Citigroup Inc. (NYSE: C) and State Street Corp (NYSE: STT) would need a larger capital cushion to mitigate another financial crisis, the Wall Street Journal previously reported. [Small Bank, Financial ETFs Could Capitalize on Looser Regulations]
The regulations would pressure profit margins at some of the largest U.S. banks and drag on large-cap financial sector ETFs, such as the Financial Select Sector SPDR (NYSEArca: XLF), which includes positions in JPM 7.3%, BAC 5.9%, WFC 8.7%, GS 2.5%, MS 1.8%, C 5.0%, BK 1.5% and STT 1.1%.
Steven Chubak, an analyst with Nomura Holdings Inc., believes that J.P. Morgan, Citigroup and Bank of America stand to take the brunt of the hit, adding that the higher capital relative to earnings could diminish the banks’ value by 3% each.
“It was curious that the Fed, in proposing a new surcharge for U.S. banks, that they would choose to in effect double down on an arguably flawed methodology, especially one that would cause a U.S. bank’s surcharge to increase merely because of the dollar strengthening,” John Gerspach, chief financial officer of Citigroup, said, arguing that the dollar’s rise against the euro likely meant the bank would face a higher surcharge.
The Fed’s proposed rule would phase in starting in 2016 and would be fully implemented in 2019. The banks would meet the new requirements by funding themselves with less borrowed money and more common equity, which would diminish profitability or their return on equity.
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